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Coronanomics: Figuring Out CBN's Recent Policy Intervention

Monetary Policy	3355 VIEWS
Monetary Policy
3355 VIEWS

Tuesday, March 17, 2020/ 02:30PM / TheAnalyst / Proshare Research Image Header Credit: EcoGraphics

Against the background of global Central Banks cutting interest rates and buying back domestic treasuries (T-bills and bonds), Nigeria's Central Bank recently announced six strategic policy initiatives to head off a recessionary dip as the Coronavirus pandemic takes a toll on global economies and threatens to lead them into a recession.

The CBN's six policies include the following (see table 1 below):

Temporary and time-limited restructuring of the tenor and loan terms for businesses and households. This should create stability of the lending sector as disruptions to business would make repayments difficult, thereby increasing the non-performing loans (NPLs) of the sector which had gradually started sliding towards the CBN required rate per bank of 5% or less.

Cutting down of interest rates on intervention programmes from 9% to 5%. The rate cut on intervention fund would cushion the adverse consequence of business disruption that would likely result from production closures, supply chain disruptions and demand collapse as social distancing and restricted movement lead to lower domestic consumer and producer spending

A N50bn targeted credit facility would be expected to assist in creating liquidity in the domestic credit market. The support of the credit market with an additional N50bn may prove inadequate to repel a recession as it would not address the tricky problems of supply chain disruptions, rising domestic inflation rate (reduced real consumer spending power) and the rising risk of lending into a reclining domestic economy.

Regulatory forbearance would mean that the CBN would ease enforcement of strict rules around advancing credit. The relaxed enforcement regime would allow the banks give customers breathing space to repay loans without suffering heavy charges against their profit and loss accounts by way of impairments. In other words, the CBN would hope to keep the financial system, particularly the credit market, stable. The move is commendable but may not achieve much as the problem would still remain the lack of production throughputs to create sellable goods which in turn would generate revenues, profits and free cash flows.

Strengthening loan to deposit ratio (LDR0 of banks is obscure. The CBN raised LDR twice in 2019 and banks are still struggling to meet the recent 65% ratio. Pushing banks to lend further in a recessionary environment could adversely impact the industry's falling non-performing loans (NPLs)

Support for the health care industry is a brilliant initiative, except for the fact that if health care companies cannot import critical inputs to manufacture drugs, no matter how low interest rates become or how much credit they can get, the financial situation of pharmaceutical companies may not improve significantly. To get Pharma running supply chains need to be restored and effective demand of consumers augmented.

Table 1 CBN's Coronavirus - induced Policy Response; A Poor Time To Die

CBN and The Rest of The World

Analysts believe that the CBN policy response to the Coronavirus or COVID-19 was late. The argument was that the central bank needed to have anticipated the consequences of an economic slowdown and put a counter-recessionary monetary framework in place as early as the first known incident of the virus in February 2020. This may be somewhat of a stretch. The problem with the COVID-19 virus response by global central banks is that they have adopted rapid monetary policy action to what remains a public health pandemic.

The challenge is not stimulating growth by way of lower interest rates and increased money supply but by taking charge of the pandemic by limiting and reversing its spread. The slowing down of the disease is a health management problem and not an economic problem. The use of monetary and fiscal tools can only prove effective when supply chains are settled and manufacturers start up production. The revival of production would require re-establishing forward contracts and ensuring that demand cycles are restored. The point of relevance of interest rate cuts and money supply growth would be to reduce production costs and improve demand (see illustration 1 below).

Illustration 1 Nigeria's Budget 2020, Recessionary Troubles Ahead

In the last two-weeks central banks around the world have announced bold rate reductions but this has not inspired manufacturing output and growth as the effects of the virus has led to a shutdown of economic activities in Asia, the Americas and Europe. To make matters worse a festering price war in the international oil market between Saudi Arabia and Russia has sent oil prices diving to prices last seen during the global economic recession in 2016. As of Wednesday, March 18, 2020 oil prices dipped to US$27.88 per barrel for Brent Crude and US$25.32 per barrel for West Texas Intermediate (WTI). The coordinated global attempt at containing a looming recession is courageous but ineffectual (see policies of global central banks in table 2 below).

Table 2 Global Central Bank's Anti-Recession Policies: Looking Through Dark Glasses

Source: CNBC, Reuters, Wall Street Journal, Proshare Research

Africa's Delayed Hard Luck

Africa, until last week, had shown disdain for the global spread of COVID-19. The continent appeared to be in suspended animation as the rest of the world struggled to contain the virus. Unfortunately, that lack of strong and assertive policy action may usher in the continents darkest months as the virus gains momentum and stretches the continents phenomenally weak health infrastructure to its limits. Nigeria's early response was smart but inadequate. The government appeared to be more concerned with optics than the grave economic and social disruption staring the country in the face. After the first index case was successfully identified and contained, rather than build on the protocols and improve the infrastructural and human preparedness the governments at all levels took it for granted that the country had inexplicable immunity from the disease. On Sunday, March 15, 2020, a 70-year lady that travelled back to Nigeria after visiting her children in the United Kingdom tested negative for COVID-19 but died in Enugu. The death was alleged to be the consequence of poor management of the case and the excessive trauma suffered by the senior citizen. The Enugu incident was symptomatic of the overall challenge of managing the virus in both Nigeria and the rest of Africa.

In fact, as at Wednesday, March 18, 2020 Nigeria recorded five additional cases of the virus, resulting from Nigerians returning from either the UK or USA. The new cases brought the total number of confirmed cases of COVID-19 in Nigeria to 8. The rise in the number of cases reflects the slow decision to place travel restrictions on people coming from countries with high incidences of the virus. The government only placed a travel ban on the following countries after the new cases were announced:

China
Italy
Iran
South Korea
Spain
Japan
France
Germany
Norway
The USA
The UK
Netherlands
Switzerland

Nigeria, Africa's largest economy by real gross domestic product (GDP) may soon witness major supply chain disruptions, production shutdowns, job losses (permanent and temporary), a rise in inflation (inflation rate for February 2020 was +12.20% up from +12.13% in January 2020) and a collapse of the public health system puts pressure on the five (5) special virus containment and intervention centres.

The challenge of COVID-19 containment in countries like Nigeria, Algeria, Egypt, and South Africa mean that Africa would need to ramp up its efforts at ensuring that the virus does not spread much further as their relatively weak health infrastructure would prove inadequate. The poor health structures would be further endangered by underlying economic weaknesses.

Coronanomics and its Many Troubles

African economies will go into recession as dwindling oil prices put added revenue pressures on countries like Nigeria and Angola. Both Nigeria and Angola will see their foreign reserves fall (Nigeria's foreign reserve currently hovers slightly above US$36bn) and their currencies slide as additions to reserves thin down as oil prices tumble. South Africa is already in the thick of a recession that may get worse if exports slow down considerably and export prices slump. Egypt is in the same position as other oil producing African countries but with a better foreign exchange outlook.

In Nigeria, the central bank's expansionary monetary policy would not work as oil, the country's largest foreign exchange earner and export, is currently trapped in a buyers-market meaning that the country has no wiggle room to increase either output or price. No matter how much the CBN cuts domestic interest rates the Bank will be incapable of stimulating growth as production is clamped by both low demand and inadequate supply chain deliveries, an outcome witnessed by many other countries in Q1 2020.

The Nigerian budget for 2020 has been torn in tatters. The economy will witness both lower revenues and lower expenditures (a tendency towards recession) and would likely see a rise in domestic prices and a fall in the external value of the Naira (see illustration 2 below). This would present the classic case of inflationary stagnation or "stagflation" which is a recession accompanied by rising average monthly or annual prices.

Illustration 2 A Helicopter view of the Impact of Coronavirus in Q1 2020

In its policy response, the CBN granted DMB's leave to consider temporary and time-limited restructuring of tenor and loan terms of businesses in oil and gas, agriculture and manufacturing as well as households affected by the outbreak of COVID-19. The problem with this policy is that it does not clarify if there are outlined incentives/relieves that will be given to commercial banks to enable them carry out this operation. A major issue arising from this policy is that the sectors outlined to benefit from this policy are forecasted to be negatively affected by the coronavirus. The fall in the global oil demand as well as the price war between Saudi-Arabia and Russia has negatively affected the oil sector.

Also, Nigeria's manufacturing sector will be negatively affected as a result of disruptions in global supply chains. It is worthy of note that 'root cause analysis' would suggest that the CBN's influence over manufacturing sector has limitations. Latest Q4 2019 data reveals that 73.13% of Nigeria's import are manufactured goods and the majority of Nigeria's SME's depend on importation (see table 3 below).

Table 1: Nigeria's Sectors % Share of Total Imports

Sectors	Q4 2019	% Share of Total Imports
Agricultural Goods	233,330.20	4.36
Raw Materials Goods	335,811.12	6.28
Solid Mineral Goods	18,487.56	0.35
Energy Goods	9.73	0.00
Manufactured Goods	3,912,209.65	73.13
Crude Oil	0.00	0.00
Other Petroleum Oil products	849,780.36	15.88
Total	5,349,628.63	100.00

Source: NBS, Proshare Research

A major highlight from the CBN's policy response is that it fails to provide clarity on how it intends to strengthen the loan to deposit ratio (LDR) of banks already squirming under the prevailing 65% ratio. DMBs have already struggled to meet the present LDR requirement, a further increase of the LDR would create problems of adverse selection and moral hazard.

The fixed income market, however, looks sober but normal. Nigeria's 10-year government bonds have a 13.248% yield. The 10 year versus 2-year spread is 524.6 basis points. This shows a normal convexity in long-term versus short-term maturities. The CBN rate is 13.5%. Nigeria's Standard & Poor rating is B.

What can CBN do better?

To get out of the bind the fiscal and monetary policy makers must start with a root cause analysis. The problem is one of heath care management which means policies must be put in place to contain the spread of the virus, this is the first order role of the government. The country's medical facilities must be quickly scaled up across the country's six geopolitical zones, health care professionals must be paid special allowances to compensate for the additional hazards of patient treatment under the circumstances and public gatherings should be curtailed to the barest minimum. The curtailment of movement has helped countries like China, Italy and Taiwan get a hold over the spread of COVID-19.

The CBN may need to do the following to provide future positive outcomes with monetary policy:

Evaluate and implement a proper policy response in the context of the peculiarity and uniqueness of the Nigerian economy.
Embark on root cause intervention to enable policies tackle specific challenges unique to different sectors
The CBN should focus primarily on monetary policy and work collaboratively with the fiscal and health authorities

The world and Nigeria is going into uncharted territories and the best way forward is to think, fast, act faster and seek clarity in continuous and reinforcing decision loops.